Mergers and acquisitions have been the obvious route for recession-ravaged Western companies looking to capture shares in the high-growth economies of Brazil, Russia, India, and China, as well as newer economies throughout Asia, the Middle East, and Africa. But with bank credit more expensive and difficult to come by following the global financial crisis in 2008, companies are taking a harder look at the effectiveness of buying their way into emerging markets.
Instead, the recent trend has increasingly been for Western companies to turn to joint ventures and strategic alliances for the purposes of entering hard-to-penetrate emerging markets and developing non-organic growth.
Although joint-venture activity has declined in the wake of the global financial crisis, the last two years have seen a resurgence of such tie-ups across all sectors, including retail, pharmaceuticals, telecommunications, banking, oil and gas, and even book publishing .
This spring alone, British fashion brand Paul Smith set about re-entering China through a partnership with Hong Kong-based ImagineX - five years after losses forced the brand to retreat from the country. Elsewhere, General Electric linked up with Shanghai-listed XD Electric to sell equipment for power transmission and distribution in China and around the world; Renault-Nissan formed a joint venture with Russian Technologies, the state industrial conglomerate, to hold a 74.5 percent stake in AvtoVaz, Russia's oldest and biggest auto manufacturer; and Nestlé, the Swiss food group, announced plans to invest more than CHF5.3 million (US$5.7 million) in Morocco to boost its milk collection and production.
"Most companies in an ideal world would want a controlling deal and buy 100 percent of a company - that is typically their default position," says Paul McNicholl of the Linklaters law firm in London. "But in recent years, a number of factors have prompted more clients to come to us and ask for a different route to doing deals in emerging markets and not just straight M&A."
One obvious factor is regulation. In some cases, limitations on foreign ownership make alliances the only route into emerging markets. Foreign single-brand retailers, for example, are allowed to operate in India only through a 50/50 joint venture with an Indian company. Foreign multibrand retailers are barred from setting up shop in India altogether in order to protect the country's local players - including its estimated 12 million "mom and pop" shops. "A joint venture is mandatory to build cars in China," says Aaron Lo, a partner in KPMG in China. "So it is a balancing act between gaining share and not giving too much away." Maybe not something investors would do by choice. But both the lackluster pace of economic recovery in the United States and Europe and the ongoing global banking crisis have also done much to accelerate the trend.
Sluggish recovery is forcing an ever greater number of Western companies to look beyond their traditional stomping-grounds and focus on emerging and frontier markets as sources of growth. This in turn has been driving up the premiums that companies now have to pay for a controlling-stake deal in emerging markets. Meanwhile, the liquidity squeeze has meant finding financing for any such deal has become more complicated and expensive.
"As the cost of doing an outright acquisition has become more challenging, more companies are seeing sub-100 percent joint-venture deals as a sensible way to gain a foothold in a country with a smaller up-front cost," says McNicholl.
Precise figures for joint ventures between Western and emerging-market companies are hard to come by simply because no one tracks them. But data from mergermarket on foreign direct investment in emerging markets by Western companies, and data from Dealogic on joint ventures in emerging markets suggest that the trend is rising.
There were 220 joint ventures, worth US$12.1 billion, in emerging markets last year, according to Dealogic. While this figure represents a slight decline from the US$15.5 billion recorded in 2010, it remains the second best year on record for emerging-market joint ventures and is over double the US$5.2 billion recorded for 2000. Not surprisingly, China, whose fast-growing retail and consumer markets have had Western retailers salivating, topped the list of destination countries for joint ventures. The world's second-largest economy led the pack for all but one year between 2004 and 2011.
While the Dealogic data do not indicate who is doing the joint ventures in emerging markets (Western companies or other emerging-market companies), foreign direct investment data from mergermarket provide a clue. From a mere US$17 billion in 2002, FDI in emerging markets from Western companies hit US$105 billion in 2007. The figure fell to US$35.7 billion in 2009 in the wake of the global financial crisis but bounced back to hit US$71.4 billion last year. If you plot mergermarket's data against those from Dealogic, you will see that the flow of FDI from Western companies into emerging markets has broadly tracked the rise and fall of joint ventures in emerging markets.
Western interest in emerging-market joint ventures can only grow as companies pursue further cost reduction and renew their focus on growth, especially in emerging markets, according to cross-border M&A specialists. "Compared with acquisitions, joint ventures provide an appealing way to accelerate entry into a new market with fewer financial or reputational risks than going at it alone," says Federico Membrillera, head of corporate finance at Delta Partners, a telecoms, media, and technology consultancy in Dubai. "Also, joint ventures promote knowledge exchange and innovation while they allow the joint-venture partners to focus on their core competencies."
The bookkeeping of joint ventures also remains convincing. In the case of telecoms, Membrillera reckons a successful alliance has the potential to achieve a 1 to 4 percent increase in revenue, a 4 to 6 percent decrease in operating expenses, and a 5 to 9 percent increase in capital-expenditure optimization.
In retail, the case for partnering up with a local company is particularly strong. It can often be a quicker and more cost-effective way for a Western multinational to distribute its goods in a country compared to the hard work of building up its own network from scratch.
This was the logic behind US home-appliance maker Whirlpool's decision earlier this year to form a sales and distribution alliance with Chinese retailer Suning Appliance. The deal, aimed at boosting Whirlpool's small share of China's burgeoning white-goods market, will see the world's largest maker of washers and refrigerators get "preferential access" to 1,700 Suning stores in nearly 300 cities across China. In return, Suning will get exclusive rights to Whirlpool products, according to Ian Lee, vice president of North Asia at Whirlpool.
"China is not the easiest market to work in," says Lee. "It is one of the most competitive markets in the whole world. It is also a very big country. Every province is like a single country. For us to build a presence across China, we would have to do it one city at a time, and this would have involved building customer services, infrastructure, logistics, all of which are very costly and labor-intensive. Suning has a presence in every province and offers a cost-effective way to expand and accelerate our reach in the country."
Similarly, when US clothing retailer The Gap decided to step up its overseas presence in places such as Panama, South Africa, Lebanon, Georgia, and Azerbaijan, it did so through franchise partnerships.
"Gap's entry into these smaller countries is low risk and high return because they are not going in there and building bricks-and-mortar stores themselves," says Richard Jaffe of financial services company Stifel Nicolaus. "Rather, they are doing it through a franchise agreement with a local partner. In return, Gap can leverage its brand name and promote its e-commerce presence. It's lucrative and costs Gap nothing."
In other sectors, partnerships and joint ventures are also becoming more focused on addressing a specific need, such as gaining access to new technology, collaborating on research and development, or tapping into a pool of highly skilled workers for less money.
The looming expiration of US patent protection on top-selling drugs such as Plavix, a blood-thinner, has sent companies in the pharmaceuticals industry scrambling to diversify their income streams. Earlier this February, Merck announced a partnership with two Brazilian drugmakers, Supera Farma Laboratórios and Eurofarma, to sell and distribute its drugs in Brazil. The same month, Pfizer announced that it had entered into a framework agreement with China's Zhejiang Hisun Pharmaceutical, a leading producer of active pharmaceutical ingredients, to establish a joint venture to develop, manufacture, and sell generic drugs in China and on the global market.
"It's a way to access our partner's portfolio and tap into local manufacturing and distribution capacity," says Petra Danielsohn-Weil, head of strategy for Pfizer's emerging-markets business.
For local companies in emerging markets, alliances can be an attractive means to learn from their bigger and more established foreign peers. In some cases, it might also be the only way - short of selling the company outright - to survive once the home market has opened to new entrants bringing global brands or technology.
Yet in spite of the rise in popularity of joint ventures between emerging-market and global companies, and their apparent win-win character, there remain many drawbacks to such alliances. Given the substantial differences in scale, company cultures (including governance), and strategic interests, they are often harder to pull off. This is especially true given that most global companies are considerably larger than their emerging-market partners.
Lee from Whirlpool says although the US company entered China in 1994, it went through a number of unsuccessful partnerships with local companies before it finally found the right ones. In addition to Suning, which handles distribution, the company has a manufacturing joint venture in China with Hisense Kelon Electrical Holdings. "Joint ventures between emerging-market and Western companies present their own risks and challenges," says McNicholl of Linklaters. "Ultimately, joint ventures that fail do so because the commercial interests of the two parties are no longer aligned.
"The advantage of finding a local partner is to mitigate the local country risks," he continues. "But at the same time companies and markets evolve. All is fine if neither companies are competing against one another, but it gets more complicated, for example, when the local partner starts applying know-how from their joint-venture partner companies and starts making products that compete directly against them."
Something of the sort appeared to have been the case with Danone, the French food group. In 2009, the company quit its joint venture with Hangzhou Wahaha, China's leading drinks group, following more than two years of legal battles. Danone and Wahaha used their joint venture, created in 1996, to develop many of China's top drinks brands; up until the dispute it was seen as one of the most successful in China. But the relationship soured in 2007 after Danone accused Wahaha and Zong Qinghou, the Chinese company's founder, of setting up a lucrative parallel operation that bottled and sold the same drinks as the joint venture did.
Making sure that the commercial interests of both parties are continuously aligned is a constant balancing act. As an example, take Paul Smith's re-entry into China. Spencer Leung, a UBS analyst, points out that fashion joint ventures often run into trouble for lack of advertising spending.
"Foreign brands like to venture into China with the help of a local partner, but the two sides often disagree on who should bear the cost of promoting the brand," he told the Financial Times. "Given the short-term nature of most joint ventures in China, local partners hesitate to put their own money into advertising a brand owned by someone else. As a result, brands don't get advertised enough in a market where they are not familiar to consumers, and they fail."
And as companies in emerging markets get bigger and more confident, they are increasingly likely to want to set their own rules for alliances with Western partners, including doing the picking and choosing themselves. That was the message of an announcement last year by Wahaha in China. The drinks group said it was now looking for a wide range of international partnerships in areas ranging from product sourcing to green manufacturing methods in a bid to diversify its sales revenue and deal with quality problems in the national supply chain.